Egypt continues economic reforms with cuts to fuel subsidies

Niveen Wahish , Sherine Abdel-Razek , Friday 22 Jun 2018

Despite social and other challenges, the government is pressing ahead with its economic reform programme

Source: Dcode

Whoever said that the fasting month of Ramadan and the Eid are quiet was quite mistaken. This year, Ramadan and the Eid saw tough economic measures, with the prices of Cairo metro ticket increasing just before the month started and water prices soaring during the holy month.

The Ministry of Electricity then announced new price hikes to go into effect on 1 July. A new cabinet was sworn in on the eve of the Eid, and then came further hikes to oil products.

None of these moves was a surprise, however, as the price hikes are part of a broader economic reform programme designed to “restore macroeconomic stability, strengthen fiscal and external sustainability, and lay a solid foundation for inclusive and robust growth, and employment creation,” according to the government’s letter of intent to the International Monetary Fund (IMF).

The programme is backed by a $12 billion three-year Extended Fund Facility (EFF) from the IMF.

“The government clearly wants to send a message to the IMF and the global investment community of its strong and irrevocable commitment to a continued reform process,” said Khaled Hamza, head of investment banking at Sigma Capital, an investment bank.

Former minister of finance Amr Al-Garhi recently said that the financial results for the July 2017 to May 2018 period had confirmed that the government could meet its targets for the fiscal year that ends on 30 June, including a primary surplus of 0.1 per cent of GDP for the first time in decades and a total budget deficit of 9.8 per cent of GDP.

This is an improvement compared to the 10.8 per cent of GDP deficit in 2016-17 and from 12.5 per cent a year earlier.

According to the IMF’s third review of Egypt’s progress under the programme, the budget for 2018-19 targets a primary surplus of two per cent of GDP, keeping public debt on a downward path.

The government is targeting a growth rate of 5.8 per cent of GDP in the new fiscal year, hoping to reduce the budget deficit to 8.4 per cent of GDP and public debt to 91 to 92 per cent of GDP.

Within that framework, it is phasing out subsidies on fuel products. “Our objective is to achieve 100 per cent cost recovery in 2018-19, excluding liquefied petroleum gas,” the government said. It also said that in the event of major changes in the oil price or the exchange rate from projected levels, it would take measures to achieve the primary balance target.

Source: Naeem Brokerage

Escalating Oil Prices

This week’s fuel hike could fall within that category of measures.

Mohamed Maait, the newly appointed minister of finance, has said that fuel subsidies in the 2018-19 budget are estimated at LE89 billion, compared to LE110 billion in the current fiscal year.

That figure would have more than doubled to LE180 billion on the back of escalating global oil prices if the government had not moved to cut subsidies, he said.

That extra spending on subsidies would have come at the expense of allocations for health and education and job-creation efforts, something the government could not have allowed to happen, he said.

The 2018-19 budget assumed an oil price of $67 per barrel. However, benchmark Brent crude prices have risen since the beginning of 2018 to almost $80 per barrel.

The subsidy cuts are important not only to fend off the extra costs from the rising oil prices, but also because studies have shown that they tend to distort the economy and not reach those who need them most.

“Energy subsidies as a distributive tool of social welfare have proved to be an inefficient and regressive way of transferring benefits to the poor in developing countries and in Egypt,” said a 2016 study entitled “Subsidy Reform in Egypt: The Gender-Energy Poverty Nexus”.

The study said that the poorest quintile of the population in Egypt, Jordan and Lebanon received one to eight per cent of energy subsidies, compared to 38 to 86 per cent accruing to the richest quintile.

“In Egypt, the poorest 40 per cent of the population receive three per cent of gasoline subsidies, seven per cent of natural gas subsidies, and 10 per cent of diesel subsidies,” the report said.

Source: Naeem Brokerage

What Do Other Countries Do?

The decision to reduce fuel subsidies on the back of increased global oil prices has become common practice. 

Tunisia, which had budgeted 1.5 billion dinars in subsidies, would have had to spend a further four billion to avoid a rise in pump prices due to increases in global oil prices.

It raised fuel prices twice in three months, but by a meagre three per cent each time, and it is now expected to do so again in line with recommendations from the IMF after a $2.8 billion loan.

Jordan has been witnessing monthly hikes in fuel prices since the beginning of 2018, a trend halted in May on the back of protests against increased fuel and electricity prices together with other austerity measures.

However, the May decision was not to freeze the increases, but to postpone them for a month. The new increases in fuel prices will be the fifth since the beginning of 2018.

Oil-rich Saudi Arabia and the United Arab Emirates have taken more aggressive steps on fuel subsidies. The UAE became the first country in the Gulf to remove subsidies on transport fuel when it began linking petrol and diesel prices to global oil markets in August 2015.

Saudi Arabia, which increased fuel prices by 127 per cent in January, has adopted an energy subsidy phase-out programme that ends petrol and diesel subsidies in 2025.

Other countries have opted to shoulder the burden instead of passing it onto consumers. Thailand is using a state oil fund to support domestic retail fuel prices to help consumers cope with rising global oil prices, for example. The fund, of about 30 billion baht ($936.9 million), will absorb 50 per cent of any increase in retail prices.

Neighbouring Malaysia has an even better strategy: the government has allocated three billion ringgit ($760 million) to subsidising petrol pump prices until the end of 2018 in spite of current plans to deal with escalating debt levels. 

Persistent Deficits

However, while the government is trimming its subsidy spending to trim its deficit, some experts worry about ballooning debt-service payments which makes it harder to meet the deficit target. 

Al-Garhi told parliament earlier this month that “we are facing a total debt with very high debt servicing” when discussing a report on the 2018/19 draft budget. Egypt’s public debt has increased to around 100 per cent of GDP.

However, according to Hamza of Sigma Capital, the debt-service problem is a “short-term, short-lived by-product of the all-time-high spike in interest rates.” These were hiked after the floatation of the Egyptian pound to accommodate the steep inflationary repercussions of a weaker currency, he explained.

“These high interest rates should continue to come down with the levelling off in inflation. The Central Bank of Egypt has cut interest rates by 200 basis points already this year, and the monetary easing cycle should continue in the fourth quarter of 2018 after bypassing the blip in inflation this summer that will be triggered by the recent subsidy cuts.”

Hamza stressed that “subsidy reform ensures the sustainability of the government’s long-term fiscal targets, whereas the debt burden is an offshoot of the short-term tight monetary policy.”

He said that the fact that the budget had showed a primary surplus in fiscal year 2017-2018 for the first time in years meant that the reform measures were bearing fruit. A primary surplus means that budgetary revenues outpace expenditures before accounting for debt servicing.

The Social Price

The increases come at a time when Egyptian households are already struggling to make ends meet, however. 

A myriad of austerity measures, including currency devaluation, introducing a new value-added tax, and slashing subsidies have increased the cost of living for all families in all social strata by at least 30 to 50 per cent over the last year and a half.

Mohamed Habib, a teacher, said that he had read on social-networking platforms that the items seeing the highest price increases were diesel, petrol and gas canisters, all of which were mainly used by those in low-income brackets.

The government’s justification is that these are items that are highly subsidised, but wasn’t it the state’s role to shoulder this burden, Habib asked.

“Even if it wants to transfer part of the burden to citizens, this should happen in a fair way so that all income brackets share equal burdens. How can the state subsidise the gas used by a cement or steel company that make millions in exports when poorer people are having to pay the full cost of the cooking gas they use to make a cup of tea at home,” he demanded.

Mohamed Ghoneim, an accountant who moonlights as a taxi-driver, expressed another frustration. “We patiently bore the three previous hikes over the last three years in the hope of a promised improvement in living conditions. But are there better public transport services or better medical services? The answer is a big no,” he said.

The government revealed its social spending package last month aimed at cushioning the effects of the recurrent price increases. Pensions for state employees and army personnel are set to increase by 15 per cent as of 1 July.

In addition, employees who fall under the civil service law of 2016 will receive a seven per cent increase in their basic salaries, while employees who do not fall under the law will get a 10 per cent pay rise.

The social security package is expected to include a small increase in the monthly allowances given to cardholders to buy subsidised food as well as an exceptional raise for civil servants and extra allotments for the conditional cash-transfer programmes Takaful and Karama, according to press reports.

“But what is the use of a seven or 10 or even 20 per cent increase in wages if prices are increasing at a faster pace,” asked Ghoneim who has four children at different educational stages.

“Some passengers riding with me say there is no real poverty in the country anymore, as the malls and supermarkets are full of shoppers. But I respond by saying that these do not represent more than 10 to 20 per cent of the population.”

“This Eid, the streets were empty not because it was a holiday or the hot weather, but because people did not have any money to spend, especially after the news of the fuel price hikes on the second day of the Eid,” he said.

Expected Inflation

Based on the hike in inflation rates after the two previous fuel-subsidy reductions, analysts believe inflation could jump in the coming months.

“June and July’s monthly inflation is expected to jump to three and two per cent, respectively, with the second half of the year standing at 0.6 to 0.8 per cent and pushing annual inflation to a peak of 15 per cent by the beginning of 2019,” stated a note by CI Capital.

Hamza agrees that with the 15 to 16 per cent expected peak for the year, adding that “market anomalies and supply chain bottlenecks could even bring it to 17 per cent.”

After peaking at 33 per cent in July, the inflation rate has been easing down. The annual inflation rate in urban parts of Egypt in May rose at its slowest pace in more than two years when consumer prices were 11.4 per cent higher. Prices rose 0.2 per cent month-on-month, compared with 1.5 per cent in April.

The Central Bank has set a target range of 13 per cent (+/-3 per cent), and inflation is expected to relax by the end of the year. 

Further Increases In Prices?

Hamza does not expect to see another hike in fuel prices soon, but he added that this would depend on the behaviour of oil prices and the value of the dollar versus other currencies. 

He said budgetary estimates for oil prices at $67 per barrel were reasonable, but was concerned about the exchange rate estimate of LE17.25 per dollar.

He expects emerging market currencies to come under further pressure with the tightening of monetary conditions in the US. The US Federal Reserve has hiked interest rates twice since March this year, bringing US rates to around two per cent and indicating that two more increases are likely this year.

Higher US interest rates could draw investors in bonds and government debt to the US and spark an outflow of capital from emerging markets.

Moreover, Hamza believes Egyptian policy-makers have vested interests in maintaining a weaker pound to attract foreign direct investment and ward off “excessive” imports. 

More Subsidy Reductions

The move to decrease subsidies this time round has increased the government’s cost-recovery ratio of different fuels from 50.3 per cent to 68.9 per cent, which brings things close to the 100 per cent target by June 2019. 

“The government would need to increase the prices of petroleum products by around 50 to 60 per cent from June 2018 to June 2019 in order to close at 100 per cent by the end of 2018-19,” said CI Capital.

However, timing is critical, and the government will need to be cautious while moving prices so as to maintain the positive real interest rate environment that means interest rates stay higher than the rate of increases in prices as well as to limit inflation rates.

Taking inflation into consideration and testing price hikes on three different dates, November 2018, February 2018, and June 2019, it was found that the only successful date would be June 2019, as the expected inflation rate would not then reach 18 to 19 per cent, the government calculated.

*A version of this article appears in print in the 21 June 2018 edition of Al-Ahram Weekly under the headline: Economic reforms continue  

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